The Last Word On Retirement Planning

Once you finish reading this column, you will never need to read another article about how to manage your retirement nest egg.

This is going to be an honest discussion about what we can control and what we can’t. We are going to dispense with wishful thinking. We are going to ignore historical results. We are going to eliminate the word “guaranteed” from our vocabulary, and we are going to use the word “promised” in its place. Then we are going to remind ourselves that promises can be broken.

The impetus for this commentary is an article that ran in The Wall Street Journal earlier this week. Headlined “Say Goodbye To the 4% Rule,” it noted that a rule of thumb that was popular in recent years (though never with me) has fallen into disfavor. That idea was that if you kept 60 percent of your retirement kitty invested in stocks and 40 percent in bonds, you could withdraw 4 percent of your portfolio’s initial value in the first year and the same – plus an inflation adjustment – in subsequent years, without ever running out of money.

There are several problems with this approach, but the one the article described as the deal-breaker is the risk of a deep and prolonged downturn in the stock market shortly after withdrawals begin. Because the distributions are based on the portfolio’s pre-crash value, the first withdrawals take out more money than the portfolio can later recover.

The Journal’s article offered three alternative approaches. I dislike all of them, in varying degrees.

The first, buying an annuity, is the worst. Annuities, sold by insurance companies, are usually expensive to buy and expensive to hold because of various layers of fees. They substitute the insurer’s investment results for yours, which may or may not be a good trade. If the insurer promises more than its long-term investment results can deliver, you have to count on the company to make up the difference from its own assets – for you and many other customers. Buying an annuity today also means, in many cases, locking in today’s record-low interest rates for the rest of your life. I don’t see why anyone would want to do that.

Insurers have developed all sorts of spin to try to counter these basic facts. I am not buying any of it, and I’m not buying annuities, either.

The second idea is to vary your annual portfolio withdrawals according to changes in your investments’ value, and according to your remaining life expectancy as set out in tables published by the Internal Revenue Service. This idea will work pretty well for people in their 60s and 70s, who have a decade or two of remaining life expectancy and whose annual withdrawals, in percentage terms, will be modest. It will work much less well for people in their late 80s and 90s, when life expectancy drops into the single digits and the withdrawal rate, in turn, would rise to the double digits.

The third approach is a stock analyst’s technique of pegging your withdrawal rate to the stock market’s reported price-to-earnings ratio. Only an investment analyst would even think of trying to implement this approach, so I am not going to address it further, except to say that it seems to pay more attention to the theory of what your stocks ought to be worth than to the reality of what they actually are worth.

All of these strategies are supposed to guarantee that you will not outlive your money.

That’s a useless guarantee – and to prove it, I am going to promise that if you follow the simple strategy I am about to give you, you will never outlive your money. But you still may not be happy with the results.

Here is my strategy: At the start of every year, take out 4 percent of your portfolio for that year’s spending. Or take 5 percent. Or 6 percent. Or 10 percent, if you want.

The next year, when you take out the same percentage, your portfolio will have either shrunk or grown, so your withdrawal will either shrink or grow, too. Obviously, the higher the percentage you take out, the more likely it becomes that your portfolio will shrink rather than grow, so your annual distributions will tend to shrink over time. But because you are only taking out a fixed percentage every year, your portfolio cannot fall all the way to zero.

If you choose a small percentage, your portfolio might gain value over time, allowing your annual distributions to increase. This is the way to go if you like to have a big financial cushion or if you are simply into deferred gratification. On the other hand, if you want to have your cake right now and don’t worry about facing a bare cupboard later, take a big percentage. It’s your choice.

A lot of people will dismiss my method immediately. It does not guarantee – or promise – that the amount you can spend every year will keep up with inflation. It does not promise that your withdrawals will be enough to support you in reasonable comfort forever. It does not promise that if you need extensive care in your later years, you will have the money to pay for it.

I do not promise these things because I don’t like to promise things I cannot necessarily deliver.

If you are entering retirement, there are only a few things you can control. You can control how much you spend; you can control how much you earn (if you are healthy enough to work during your “retirement”); and you can control how you invest your savings. If you put all your savings in the bank at today’s near-zero interest rates, you won’t suffer any losses if the stock market turns downward, but you will have no chance whatsoever to grow your investments and keep up with inflation. If you put everything in the stock market, you will have growth opportunities over the long term, but you will see a lot of short-term fluctuations in value (and thus in your annual distributions). You had best be prepared to stay in the stock market through any downturns, or you will suffer the fate of your neighbors who cashed in their 401(k) plans during the crash a few years ago, which locked in their losses and prevented them from subsequently recovering along with the market.

You cannot control what the stock market will do in the future. You cannot control inflation. You cannot control how long you will live. You cannot control how much medical or custodial care you will need. There is no financial strategy or product that can give you control over these things, which nobody else can control either.

Our best chance of having a financially secure and comfortable retirement is to keep spending under control (downsize sooner rather than later) and to invest with an eye toward long-term growth. If you have a reasonably strong stomach for withstanding stock market fluctuations, I think the logical approach is to have anywhere from 50 percent or 80 percent of retirement assets in stocks. This is as true for someone at age 80 as at 60.

We all want our old-age security guaranteed, but life does not offer guarantees. It only offers promises, and promises are not always worth much.

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